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Firm Relocation Threats and Copy Cat Costs

Department of Economics, Iowa State University, 260 Heady Hall, Ames, IA 50011-1070 USA, darinw{at}iastate.edu

Maureen Kilkenny

Department of Economics, Iowa State University, 565 Heady Hall, Ames, IA 50011-1070 USA, kilkenny{at}iastate.edu

To retain firms, states are forgiving billions of dollars in tax liabilities. Some firms move even after a relief package is offered; other firms obtain tax concessions by bluffing. When firms threaten to relocate unless their current tax burden is lightened, what should a local government do? If it offers relief, at best it retains the firm, but it also encourages other firms ("copy cats") to demand similar treatment. At worst, it loses the firm and has to deal with the additional threats. Tax incentive packages can cost much more than foregone revenues related to the single threatening firm. We solve a local government's constrained optimization problem to identify its optimal response in a game theoretic framework with asymmetric information. Industrial recruitment is modeled as a sealed-bid process in which the government does not know what alternative tax package(s) may be offered to the firm. We show that the probability of a relief offer being the optimal response is positively related to the rate of expansion and indirect revenue (income and sales taxes related to firm activity in the locale) and negatively related to copy cat costs and the magnitude of tax relief. The problem is analyzed theoretically and graphically. The choice rules are related to other empirical work and illustrated numerically.

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